UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
[X] Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the quarterly period ended June 30, 2002, or
[ ] Transition report pursuant to section 13 or 15(d) of the Securities Exchange
Act of 1934
COMMISSION FILE NUMBER 1-13374
REALTY INCOME CORPORATION
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(Exact name of registrant as specified in its charter)
Maryland
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(State or other jurisdiction of incorporation or organization)
33-0580106
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(I.R.S. Employer Identification No.)
220 West Crest Street, Escondido, California 92025
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(Address of principal executive offices)
(760) 741-2111
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(Registrant's telephone number)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES [X] NO [ ]
There were 34,869,874 shares of common stock outstanding as of August 8, 2002.
REALTY INCOME CORPORATION
Form 10-Q
June 30, 2002
TABLE OF CONTENTS
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PART I. FINANCIAL INFORMATION Page
----
Item 1: Financial Statements
Consolidated Balance Sheets.................................................... 3
Consolidated Statements of Income.............................................. 4
Consolidated Statements of Cash Flows.......................................... 5
Notes to Consolidated Financial Statements..................................... 6
Item 2: Management's Discussion and Analysis of
Financial Condition and Results of Operations
Forward-looking statements..................................................... 12
The company.................................................................... 13
Recent developments............................................................ 14
Liquidity and capital resources ............................................... 16
Funds from operations ......................................................... 19
Results of operations ......................................................... 21
Properties .................................................................... 27
Impact of inflation and accounting pronouncements.............................. 32
Item 3: Quantitative and Qualitative Disclosures about Market Risk.......................... 33
PART II. OTHER INFORMATION
Item 4: Submission of Matters to a Vote of Security Holders................................. 34
Item 6: Exhibits and Reports on Form 8-K.................................................... 34
SIGNATURE .................................................................................... 35
EXHIBIT INDEX .................................................................................. 35
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
REALTY INCOME CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
----------------------------------------
June 30, 2002 and December 31, 2001
(dollars in thousands, except per share data)
2002 2001
(Unaudited)
- --------------------------------------------------------------------------------------------------------------------
ASSETS Real estate, at cost:
Land $ 436,907 $ 412,455
Buildings and improvements 792,244 765,707
- --------------------------------------------------------------------------------------------------------------------
1,229,151 1,178,162
Less accumulated depreciation and amortization (233,736) (233,848)
- --------------------------------------------------------------------------------------------------------------------
Net real estate held for investment 995,415 944,314
Real estate held for sale, net 32,706 23,356
- --------------------------------------------------------------------------------------------------------------------
Net real estate 1,028,121 967,670
Cash and cash equivalents 21,242 2,467
Accounts receivable 3,284 4,857
Goodwill, net 17,206 17,206
Other assets 10,467 11,508
- --------------------------------------------------------------------------------------------------------------------
Total assets $ 1,080,320 $ 1,003,708
====================================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Distributions payable $ 8,296 $ 6,238
Accounts payable and accrued expenses 5,578 5,834
Other liabilities 4,118 4,543
Lines of credit payable 155,800 85,300
Notes payable 230,000 230,000
- --------------------------------------------------------------------------------------------------------------------
Total liabilities 403,792 331,915
- --------------------------------------------------------------------------------------------------------------------
Commitments and contingencies
Stockholders' equity:
Preferred stock and paid in capital, par value $1.00 per share, 20,000,000
shares authorized, 4,125,700 shares issued and outstanding 99,368 99,368
Common stock and paid in capital, par value $1.00 per share, 100,000,000
shares authorized, 33,319,389 and 32,829,111 shares issued and
outstanding in 2002 and 2001, respectively 806,467 795,505
Distributions in excess of net income (229,307) (223,080)
- --------------------------------------------------------------------------------------------------------------------
Total stockholders' equity 676,528 671,793
- --------------------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $ 1,080,320 $ 1,003,708
====================================================================================================================
The accompanying notes to consolidated financial statements are an integral part of these statements.
3
REALTY INCOME CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
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For the three and six months ended June 30, 2002 and 2001
(dollars in thousands, except per share data)
(unaudited)
THREE THREE SIX SIX
MONTHS MONTHS MONTHS MONTHS
ENDED ENDED ENDED ENDED
6/30/02 6/30/01 6/30/02 6/30/01
- ------------------------------------------------------------------------------------------------------------------------
REVENUE
Rental $ 32,724 $ 28,552 $ 65,160 $ 57,025
Gain on sales of real estate acquired for
resale 1,126 161 1,491 2,089
Interest and other 51 179 83 306
- ------------------------------------------------------------------------------------------------------------------------
33,901 28,892 66,734 59,420
- ------------------------------------------------------------------------------------------------------------------------
EXPENSES
Interest 5,803 6,587 11,408 14,646
Depreciation and amortization 7,421 6,906 14,683 13,865
General and administrative 2,348 1,866 4,737 3,906
Property 622 556 1,243 1,164
Other 598 240 886 1,020
Provision for impairment loss -- 200 -- 530
- ------------------------------------------------------------------------------------------------------------------------
16,792 16,355 32,957 35,131
- ------------------------------------------------------------------------------------------------------------------------
Income from continuing operations 17,109 12,537 33,777 24,289
Income from discontinued operations 1,336 775 2,622 1,545
Gain on sales of investment properties -- 164 340 6,115
- ------------------------------------------------------------------------------------------------------------------------
Net income 18,445 13,476 36,739 31,949
Preferred stock dividends (2,428) (2,428) (4,856) (4,856)
- ------------------------------------------------------------------------------------------------------------------------
Net income available to
common stockholders $ 16,017 $ 11,048 $ 31,883 $ 27,093
========================================================================================================================
Basic and diluted net income
per common share $ 0.48 $ 0.39 $ 0.96 $ 0.98
The accompanying notes to consolidated financial statements are an integral part of these statements.
4
REALTY INCOME CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
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For the six months ended June 30, 2002 and 2001
(dollars in thousands)
(unaudited)
2002 2001
- ------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 36,739 $ 31,949
Adjustments to net income:
Depreciation and amortization 14,683 13,865
Provision for impairment losses -- 530
Income from discontinued operations (2,622) (1,545)
Cash from discontinued operations 1,833 2,048
Investment in real estate acquired for resale (4,462) (4,475)
Proceeds from sales of real estate acquired for resale 11,729 15,509
Gain on sales of real estate acquired for resale (1,491) (2,089)
Gain on sales of investment properties (340) (6,115)
Amortization of deferred stock compensation 284 145
Change in assets and liabilities:
Accounts receivable and other assets 2,496 2,149
Accounts payable, accrued expenses and other liabilities 13 (1,267)
- ------------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 58,862 50,704
- ------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES Proceeds from sales of investment
properties:
From continuing operations 1,198 19,674
From discontinued operations 6,017 --
Acquisition of and additions to investment properties (87,567) (14,438)
- ------------------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) investing activities (80,352) 5,236
- ------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Borrowings from lines of credit 165,900 44,800
Payments under lines of credit (95,400) (148,600)
Distributions to common stockholders (37,934) (30,189)
Distributions to preferred stockholders (2,974) (2,974)
Proceeds from stock offerings, net of offering costs of
$107 in 2002 and $4,452 in 2001 8,158 77,558
Proceeds from other common stock issuances 2,515 999
Repurchase of stock -- (169)
- ------------------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) financing activities 40,265 (58,575)
- ------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents 18,775 (2,635)
Cash and cash equivalents, beginning of period 2,467 3,815
- ------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents, end of period $ 21,242 $ 1,180
========================================================================================================================
For supplemental disclosures, see note 10.
The accompanying notes to consolidated financial statements are an integral part of these statements.
5
REALTY INCOME CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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June 30, 2002
(Unaudited)
1. MANAGEMENT STATEMENT
The consolidated financial statements of Realty Income Corporation ("Realty
Income", the "Company", "we" or "our") were prepared from our books and records
without audit and include all adjustments (consisting of only normal recurring
accruals) necessary to present a fair statement of results for the interim
periods presented. Certain of the 2001 balances have been reclassified to
conform to the 2002 presentation. Readers of this quarterly report should refer
to our audited financial statements for the year ended December 31, 2001, which
are included in our 2001 Annual Report on Form 10-K, as certain disclosures
which would substantially duplicate those contained in such audited financial
statements have been omitted from this report.
2. ACCOUNTING PRONOUNCEMENTS
A. In June 2001, the Financial Accounting Standards Board ("FASB") issued
Statement No. 142, Goodwill and Other Intangible Assets. Statement No. 142
changed the accounting for goodwill from an amortization method to an
impairment-only approach. Under Statement No. 142, goodwill will be tested for
impairment annually and also whenever events or circumstances occur that
indicate that our goodwill might be impaired.
We adopted the provisions of Statement No. 142 on January 1, 2002 and ceased
amortizing our goodwill, which totaled $17.2 million. During the second quarter
of 2002, we completed the transitional impairment testing of our goodwill and
found that our goodwill was not impaired. We also did not have any new goodwill
or take an impairment loss on our existing goodwill during 2002.
Amortization expense related to goodwill was $231,000 and $462,000 for the three
and six months ended June 30, 2001, respectively. We do not have any intangible
assets as contemplated under Statement No. 142 or unamortized negative goodwill.
The following table reconciles reported net income available to common
stockholders to adjusted net income available to common stockholders. It
excludes the effect of goodwill amortization expense that is no longer amortized
under Statement No. 142 (in thousands, except per share data):
THREE THREE SIX SIX
MONTHS MONTHS MONTHS MONTHS
ENDED ENDED ENDED ENDED
6/30/02 6/30/01 6/30/02 6/30/01
- ----------------------------------------------------------------- --------------- ------------- ------------- -------------
Reported Net income available to common stockholders $16,017 $11,048 $31,883 $27,093
Goodwill amortization -- 231 -- 462
- ----------------------------------------------------------------- --------------- ------------- ------------- -------------
Adjusted net income available to common stockholders $16,017 $11,279 $31,883 $27,555
================================================================= =============== ============= ============= =============
Basic and diluted earnings per share
Reported Net income available to common stockholders $ 0.48 $ 0.39 $ 0.96 $ 0.98
Goodwill amortization -- 0.01 -- 0.02
Adjusted net income available to common stockholders $ 0.48 $ 0.40 $ 0.96 $ 1.00
================================================================= =============== ============= ============= =============
B. In August 2001, the FASB issued Statement No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets. Effective January 1, 2002,
Statement No. 144 superseded Statement No. 121, Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of. Statement No. 144
6
requires long-lived assets to be disposed of to be measured at the lower of
carrying amount or fair value less costs to sell on our balance sheet. It also
broadened the reporting requirements of discontinued operations to include a
component of an entity rather than a segment of a business. Statement No. 144
states that a component of an entity comprises operations and cash flows that
can be clearly distinguished, operationally and for financial reporting
purposes, from the rest of the entity. In accordance with Statement No. 144, we
report each individual property as a reporting component for determining
discontinued operations. The operations of 34 properties listed as held for sale
at June 30, 2002, plus three properties sold during the first quarter of 2002
and 10 properties sold during the second quarter of 2002 were reported as income
from discontinued operations in 2002, and their respective 2001 results of
operations were reclassified to income from discontinued operations. As required
by Statement No. 144, three other properties reported as held for sale at
December 31, 2001 that were sold during 2002 were not reported as discontinued
operations. The following is a summary of our income from discontinued
operations for the three and six months ended June 30, 2002 and 2001 (dollars in
thousands):
THREE THREE SIX SIX
MONTHS MONTHS MONTHS MONTHS
ENDED ENDED ENDED ENDED
6/30/02 6/30/01 6/30/02 6/30/01
---------------------------------------------------------- ------------- ------------- ------------- -------------
Rental revenue $ 963 $ 1,035 $ 1,923 $ 2,058
Interest and other revenue -- -- -- 14
Gain on sales of investment properties 1,305 -- 2,079 --
Depreciation and amortization (218) (252) (460) (503)
Property expenses (44) (8) (90) (24)
Provision for impairment loss (670) -- (830) --
---------------------------------------------------------- ------------- ------------- ------------- -------------
Income from discontinued operations $ 1,336 $ 775 $ 2,622 $ 1,545
========================================================== ============= ============= ============= =============
C. In July 2002, we changed our method of accounting for stock-based
compensation to the fair value based method which is the preferred method of
accounting as provided for under FASB Statement No. 123, Accounting for
Stock-Based Compensation. The effect of the change in accounting for stock-based
compensation will be to recognize stock compensation expense over the vesting
period for those stock options granted on or after January 1, 2002. For stock
options granted prior to January 1, 2002, we will continue to apply the
provisions under Accounting Principles Board Opinion No. 25 unless the stock
options are modified or settled for cash. The impact of adopting Statement No.
123 is not expected to have a material effect on our financial position or
results of operations. We anticipate that during 2002, our stock option expense
will be approximately $12,000.
3. RETAIL PROPERTIES ACQUIRED BY REALTY INCOME
During the first six months of 2002, we invested $86.8 million in 91 new retail
properties and properties under development with an initial weighted average
contractual lease rate of 10.4%. These 91 properties are located in 24 states,
will contain approximately 430,700 leasable square feet and are 100% leased,
with an average initial lease term of 19.9 years.
During the first six months of 2001, we invested $15.3 million in seven new
retail properties and properties under development with an initial weighted
average contractual lease rate of 11.6%. These seven properties are located in
five states, contain approximately 115,300 leasable square feet and are 100%
leased, with an average initial lease term of 21.7 years.
7
4. GAIN ON SALES OF INVESTMENT PROPERTIES
During the second quarter of 2002, we sold 10 investment properties for $3.8
million and recognized a gain of $1.3 million. This gain is included in income
from discontinued operations. During the second quarter of 2001, we sold three
investment properties for $2.6 million and recognized a gain of $164,000.
During the first six months of 2002, we sold 16 investment properties for $7.2
million and recognized a gain of $2.4 million. Of this gain, $2.1 million is
included in income from discontinued operations. During the first six months of
2001, we sold 13 investment properties for $19.7 million and recognized a gain
of $6.1 million.
5. RETAIL PROPERTIES ACQUIRED BY CREST NET LEASE, INC. ("CREST NET")
A. During the first six months of 2002, Crest Net invested $3.8 million in two
new retail properties and properties under development. These two properties are
located in two states, will contain approximately 6,400 leasable square feet and
are 100% leased, with an average initial lease term of 17.6 years.
During the first six months of 2001, Crest Net invested $4.5 million in four new
retail properties and properties under development. These four properties are
located in three states, will contain approximately 15,300 leasable square feet
and are 100% leased, with an average initial lease term of 19.3 years.
B. At June 30, 2002 and December 31, 2001, investments in properties owned by
Crest Net totaled $15.9 million and $22.3 million, respectively, and are
included in real estate held for sale, net on our consolidated balance sheets.
6. GAIN ON SALES OF REAL ESTATE ACQUIRED FOR RESALE
During the second quarter of 2002, Crest Net sold eight properties for $9.0
million and we recognized a gain of $1.1 million on the sales. During the second
quarter of 2001, Crest Net sold one property for $1.5 million and we recognized
a gain of $161,000 on the sale.
During the first six months of 2002, Crest Net sold 11 properties for $11.7
million and we recognized a gain of $1.5 million on the sales. During the first
six months of 2001, Crest Net sold five properties for $15.5 million and we
recognized a gain of $2.1 million on the sales.
7. DISTRIBUTIONS PAID AND PAYABLE
A. We pay monthly distributions to our common stockholders. The following is a
summary of the monthly cash distributions per common share paid during the six
months ended June 30, 2002 and 2001. As of June 30, 2002, a distribution of
$0.1925 per common share was declared (and was paid on July 15, 2002).
Month 2002 2001
---------------------------------------------------------------------------
January $ 0.19000 $ 0.18500
February 0.19000 0.18500
March 0.19000 0.18500
April 0.19125 0.18625
May 0.19125 0.18625
June 0.19125 0.18625
---------------------------------------------------------------------------
Total $ 1.14375 $ 1.11375
===========================================================================
8
B. In May 1999, we issued 2,760,000 shares of 9 3/8% Class B cumulative
redeemable preferred stock (the "Class B Preferred"), of which 2,745,700 shares
were outstanding during the first six months of 2002 and 2001. Beginning May 25,
2004, the Class B Preferred shares are redeemable at our option for $25.00 per
share. Dividends on the Class B Preferred are paid quarterly in arrears. During
each of the first two quarters of 2002 and 2001, we paid a quarterly dividend to
holders of our Class B Preferred of $0.5859 per share, totaling $3.2 million.
The 2002 second quarter dividend was paid on July 1, 2002.
C. In July 1999, we issued 1,380,000 shares of 9 1/2% Class C cumulative
redeemable preferred stock (the "Class C Preferred"), all of which were
outstanding during the first six months of 2002 and 2001. Beginning July 30,
2004, the Class C Preferred shares are redeemable at our option for $25.00 per
share. Dividends on the Class C Preferred are paid monthly in arrears. During
each of the first six months of 2002 and 2001, we paid six monthly dividends to
holders of our Class C Preferred of $0.1979 per share totaling, $1.6 million.
The June 2002 monthly dividend was paid on July 1, 2002.
8. NET INCOME PER COMMON SHARE
Basic net income per common share is computed by dividing net income available
to common stockholders by the weighted average number of common shares
outstanding during each period. Diluted net income per common share is computed
by dividing the amount of net income available to common stockholders for the
period by the number of common shares that would have been outstanding assuming
the issuance of common shares for all potentially dilutive common shares
outstanding during the reporting period.
The following is a reconciliation of the denominator of the basic net income per
common share computation to the denominator of the diluted net income per common
share computation for the three and six months ended June 30, 2002 and 2001:
THREE THREE SIX SIX
MONTHS MONTHS MONTHS MONTHS
ENDED ENDED ENDED ENDED
6/30/02 6/30/01 6/30/02 6/30/01
- ---------------------------------------------- ------------------ ------------------ ------------------ ------------------
Weighted average shares used
for the basic net income per
share computation 33,310,413 28,393,227 33,178,176 27,507,539
Incremental shares from the
assumed exercise of stock options 57,946 75,765 52,641 57,961
- ---------------------------------------------- ----------------- ------------------- ------------------ ------------------
Adjusted weighted average shares
used for diluted net income
Per share computation 33,368,359 28,468,992 33,230,817 27,565,500
============================================== ================= =================== ================== ==================
For the three and six months ended June 30, 2002 and 2001, no stock options were
anti-dilutive.
9. STOCK OFFERINGS
A. In February 2002, we issued 273,150 shares of common stock to a unit
investment trust at a net price to us of $30.26 per share, based on a 5%
discount to the market price at the time of issuance of $31.85 per share. The
net proceeds of $8.2 million were used to repay a portion of our $200 million
credit facility.
B. In July 2002, we issued 1,550,000 shares of common stock at a price of $33.40
per share. The net proceeds of $48.8 million were used to repay a portion of our
$200 million credit facility.
9
10. SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Interest paid during the first six months of 2002 and 2001 was $10.5 million and
$14.4 million, respectively. During the first six months of 2002 and 2001,
interest of $256,000 and $187,000, respectively, was capitalized related to
properties under development.
The following non-cash financing activities are included in the accompanying
consolidated financial statements (dollars in thousands):
Restricted stock grants resulted in the following:
2002 2001
------ -------
Other assets $ -- $ 1,555
Common stock and paid in capital 3,282 1,555
Common stock and paid in capital,
Deferred stock compensation (3,282) --
11. SEGMENT INFORMATION
We evaluate performance and make resource allocation decisions on an industry by
industry basis. For financial reporting purposes, we have grouped our tenants
into 11 reportable industry segments based upon the 24 retail industries the
tenants are in, except for properties owned by Crest Net that are grouped
together and included in "other non-reportable segments." All of the properties
are incorporated into one of the applicable segments. Because almost all of our
leases require the tenant to pay operating expenses, revenue is the only
component of segment profit and loss we measure.
The following tables set forth certain information regarding the properties
owned by us, classified according to the business of the respective tenants as
of June 30, 2002 (dollars in thousands):
THREE THREE SIX SIX
MONTHS MONTHS MONTHS MONTHS
ENDED ENDED ENDED ENDED
Revenue for the: 6/30/02 6/30/01 6/30/02 6/30/01
- ------------------------------------------------------------------------------------------------------------------------
Segment rental revenue:
Automotive parts $2,458 $2,439 $5,261 $4,920
Automotive service 2,225 1,754 3,961 3,488
Child care 6,198 6,210 12,407 12,236
Consumer electronics 1,140 1,232 2,281 2,469
Convenience stores 2,613 2,529 5,171 5,044
Health and fitness 1,322 1,021 2,563 2,002
Home furnishings 1,858 1,794 3,690 3,591
Restaurants 4,456 3,143 9,006 6,393
Sporting goods 1,396 -- 2,791 --
Theaters 1,302 1,302 2,604 2,604
Video rental 1,133 1,111 2,252 2,244
Other non-reportable segments(1) 6,623 6,017 13,173 12,034
Reconciling items:
Gain on sales of real estate acquired for resale 1,126 161 1,491 2,089
Interest and other 51 179 83 306
- ------------------------------------------------------------------------------------------------------------------------
Total revenue $ 33,901 $ 28,892 $ 66,734 $ 59,420
========================================================================================================================
(1) Consolidates 13 retail industry segments and properties owned by Crest Net.
10
ASSETS
----------------------------------------------------
AS OF: JUNE 30, 2002 DECEMBER 31, 2001
- ----------------------------------------------------------------------------------------------------------------------------
Segment real estate, net of depreciation and amortization:
Automotive parts $ 74,259 $ 73,240
Automotive service 86,528 44,438
Child care 137,658 142,163
Consumer electronics 35,450 35,950
Convenience stores 112,521 81,701
Health and fitness 44,825 43,549
Home furnishings 68,032 69,008
Restaurants 126,662 129,768
Sporting goods 49,836 50,506
Theaters 46,893 47,273
Video rental 37,146 37,719
Other non-reportable segments(1) 208,311 212,355
- ----------------------------------------------------------------------------------------------------------------------------
Total net real estate 1,028,121 967,670
Non-real estate assets 52,199 36,038
- ----------------------------------------------------------------------------------------------------------------------------
Total assets $ 1,080,320 $ 1,003,708
============================================================================================================================
(1) Consolidates 13 retail industry segments and properties owned by Crest Net.
As required by Statement No. 142, we assigned our goodwill to the relevant
"reporting units" which were determined to be the seven industry segments we had
investments in at the time the goodwill originated. The following table set
forth the seven industries our goodwill was assigned to as of January 1, 2002
(dollars in thousands):
Automotive parts $ 1,935
Automotive service 1,338
Child care 5,353
Convenience stores 2,073
Home furnishings 1,557
Restaurants 3,779
Other 1,171
- ---------------------------------------------------- -------------------------
Goodwill, net $ 17,206
==================================================== =========================
11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
-----------------------------------------------------------------------
FORWARD-LOOKING STATEMENTS
This quarterly report on Form 10-Q contains forward-looking statements within
the meaning of Section 27A of the Securities Act and Section 21E of the Exchange
Act. When used in this quarterly report, the words estimated, anticipated and
similar expressions are intended to identify forward-looking statements.
Forward-looking statements are subject to risks, uncertainties, and assumptions
about Realty Income Corporation, including, among other things:
o Our anticipated growth strategies;
o Our intention to acquire additional properties;
o Our intention to sell properties;
o Our intention to re-lease vacant properties;
o Anticipated trends in our business, including trends in the market for
long-term net leases of freestanding, single-tenant retail properties;
o Future expenditures for development projects; and
o Profitability of our subsidiary, Crest Net Lease, Inc.
Future events and actual results, financial and otherwise, may differ materially
from the results discussed in the forward-looking statements. In particular,
some of the factors that could cause actual results to differ materially are:
o Our continued qualification as a real estate investment trust;
o General business and economic conditions;
o Competition;
o Interest rates;
o Accessibility of debt and equity capital markets;
o Other risks inherent in the real estate business including tenant defaults,
potential liability relating to environmental matters and illiquidity of
real estate investments; and
o Acts of terrorism and war.
Additional factors that may cause risks and uncertainties include those
discussed in the sections entitled "Business" and "Management's Discussion and
Analysis of Financial Condition and Results of Operations" in the Company's
Annual Report on Form 10-K for the fiscal year ended December 31, 2001.
Readers are cautioned not to place undue reliance on forward-looking statements,
which speak only as of the date that this quarterly report was filed with the
Securities and Exchange Commission. We undertake no obligation to publicly
release the results of any revisions to these forward-looking statements that
may be made to reflect events or circumstances after the date of this quarterly
report or to reflect the occurrence of unanticipated events. In light of these
risks and uncertainties, the forward-looking events discussed in this quarterly
report might not occur.
12
THE COMPANY
Realty Income Corporation, the Monthly Dividend Company (TM), a Maryland
corporation ("Realty Income," the "Company," "our" or "we") was organized to
operate as an equity real estate investment trust ("REIT"). We are a fully
integrated, self-administered real estate company with in-house acquisition,
leasing, legal, retail and real estate research, portfolio management and
capital markets expertise.
Our primary business objective is to generate dependable monthly distributions
from a consistent and predictable level of funds from operations ("FFO") per
share. Additionally, we seek to increase distributions to stockholders and FFO
per share through both active portfolio management and the acquisition of
additional properties.
Our portfolio management focus includes:
o Contractual rent increases on existing leases;
o Rental increases at the termination of existing leases when market
conditions permit; and
o The active management of our property portfolio, including re-leasing of
vacant properties and selective sales of properties.
Our acquisition of additional properties adheres to a focused strategy of
primarily acquiring properties that are:
o Freestanding, single-tenant, retail locations;
o Leased to regional and national retail chains; and
o Under long-term, net-lease agreements.
As of June 30, 2002, we owned a diversified portfolio:
o Of 1,199 retail properties;
o With an occupancy rate of 98.4%, or 1,180, of the 1,199 properties;
o Leased to 81 different retail chains;
o Doing business in 24 separate retail industries;
o Located in 48 states;
o With over 9.8 million square feet of leasable space; and
o With an average leasable retail space of 8,200 square feet on approximately
62,000 square feet of land.
Of the 1,199 properties in the portfolio, 1,194, or 99.6%, are single-tenant
retail properties with the remaining five being multi-tenant properties. As of
June 30, 2002, 1,175, or 98.4%, of the 1,194 single-tenant properties were
leased with a weighted average remaining lease term (excluding extension
options) of approximately 10.7 years.
In addition to our real estate portfolio, at June 30, 2002 our subsidiary, Crest
Net Lease, Inc. ("Crest Net") had invested $15.9 million in a portfolio of 15
retail properties located in nine states. These properties are held for sale.
We typically acquire, and then lease back, retail store locations from chain
store operators, providing capital to the operators for continued expansion and
other corporate purposes. Our acquisition and investment activities are
concentrated in well-defined target markets and generally focus on middle-market
retailers providing goods and services that satisfy basic consumer needs.
13
Our net-lease agreements generally:
o Are for initial terms of 15 to 20 years;
o Require the tenant to pay minimum monthly rents and property operating
expenses (taxes, insurance and maintenance); and
o Provide for future rent increases (typically subject to ceilings) based on
increases in the consumer price index, fixed increases, or additional rent
calculated as a percentage of the tenants' gross sales above a specified
level.
We believe that the long-term ownership of an actively managed, diversified
portfolio of retail properties under long-term, net-lease agreements produces
consistent, predictable income. We also believe that a portfolio of long-term
leases that require tenants to be responsible for property expenses generally
produces a more predictable income stream than many other types of real estate
portfolios, while continuing to offer the potential for growth in rental income.
Our net-leased retail properties are primarily leased to regional and national
retail chain store operators. Generally, our properties contain single-story
buildings and adequate parking on site to accommodate peak retail traffic
periods. The properties tend to be on major thoroughfares with relatively high
traffic counts and adequate access, egress and proximity to a sufficient
population base to constitute a suitable market or trade area for the retailer's
business.
We provide sale-leaseback financing primarily to less than investment grade
retail chains. From 1970 through December 31, 2001, we acquired and leased back
to regional and national retail chains 1,158 properties (including 83 properties
that have been sold) and collected approximately 98% of the original contractual
rent obligations on those properties (this information annually.) We believe
that within this market we can achieve an attractive risk-adjusted return on the
financing we provide to retailers.
RECENT DEVELOPMENTS
ISSUANCE OF COMMON STOCK. In February 2002, we issued 273,150 shares of common
stock to a unit investment trust at a net price to us of $30.26 per share, based
on a 5% discount to the market price at the time of issuance of $31.85 per
share. The net proceeds of $8.2 million were used to repay a portion of our $200
million credit facility.
In July 2002, we issued 1,550,000 shares of common stock at a price of $33.40
per share. The net proceeds of $48.8 million were used to repay a portion of our
$200 million acquisition credit facility.
FUNDS FROM OPERATIONS (FFO). For the second quarter of 2002, our FFO increased
by $4.8 million, or 26.4%, to $23.0 million compared to $18.2 million for the
same quarter in 2001. In the first six months of 2002, our FFO increased by $9.6
million, or 26.8%, to $45.4 million compared to $35.8 million for the first six
months of 2001. See our discussion of FFO in this "Management's Discussion and
Analysis of Financial Condition and Results of Operations."
In the second quarter of 2002, Crest Net generated $901,000 in FFO for Realty
Income compared to $141,000 in the same quarter of 2001. In the first six months
of 2002 and 2001, Crest Net generated $1.3 million in FFO for Realty Income. The
future contribution, if any, to our FFO by Crest Net will depend on the timing
and the number of property sales it achieves, if any, in a given period.
NET INCOME AVAILABLE TO COMMON STOCKHOLDERS was $16.0 million in the second
quarter of 2002 and $11.0 million in the second quarter of 2001, an increase of
$5.0 million. Net income available to common stockholders was $31.9 million in
the first six months of 2002 and $27.1 million in the first six months of 2001,
an increase of $4.8 million.
14
ACQUISITION OF PROPERTIES DURING 2002. During the second quarter of 2002, we
invested $79.0 million in 88 new retail properties and properties under
development with an initial weighted average contractual capitalization rate of
10.4%. During the first six months of 2002, we invested $86.8 million in 91 new
retail properties and properties under development with an initial weighted
average contractual capitalization rate of 10.4%. The 91 new properties are 100%
leased with an initial average lease length of 19.9 years and will contain
approximately 430,700 leasable square feet.
SALES OF INVESTMENT PROPERTIES. During the first six months of 2002, we sold 16
properties for $7.2 million and recognized a gain of $2.4 million. Of this gain,
$2.1 million is included in income from discontinued operations. The 16
properties consisted of seven child care facilities, eight restaurants and one
racquetball facility. The proceeds from the sale of these properties were used
to repay outstanding indebtedness on our $200 million credit facility and to
invest in new properties.
CREST NET. During the second quarter of 2002, Crest Net sold eight properties
from its inventory for $9.0 million and we recorded a gain on the sales of $1.1
million. During the first six months of 2002, Crest Net sold 11 properties from
its inventory for $11.7 million and we recorded a gain on the sales of $1.5
million. During the first six months of 2002, Crest Net invested $3.8 million in
two new retail properties and properties under development. At the end of the
second quarter, Crest Net carried an inventory of $15.9 million, which is
included on our balance sheet in real estate held for sale, net.
The financial statements of Crest Net are consolidated into Realty Income's
financial statements. All material intercompany transactions have been
eliminated in consolidation.
INCREASE IN MONTHLY DISTRIBUTIONS TO COMMON STOCKHOLDERS. We continue our
33-year policy of paying distributions monthly. Monthly distributions per share
were increased $0.00125 in January 2002 to $0.19, in April 2002 to $0.19125 and
in July 2002 to $0.1925. The increase in July was our 19th consecutive quarterly
increase and 21st increase since 1995. During the first six months of 2002, we
paid three distributions of $0.19 per share and three distributions of $0.19125
per share, totaling $1.14375 per share. In June and July 2002, we declared
distributions of $0.1925 per share, which were paid on July 15, 2002 and payable
on August 15, 2002, respectively.
The monthly distribution of $0.1925 per share represents a current annualized
distribution of $2.31 per share, and an annualized distribution yield of
approximately 6.9% based on the last reported sale price of the Company's Common
Stock on the NYSE of $33.30 on August 8, 2002. Although we expect to continue
our policy of paying monthly distributions, we cannot guarantee that we will
maintain the current level of distributions, that we will continue our pattern
of increasing distributions per share, or what the actual distribution yield
will be for any future period.
OTHER INFORMATION
Realty Income's common stock is listed on the New York Stock Exchange ("NYSE")
under the ticker symbol "O", our central index key ("CIK") number is 726728 and
cusip number is 756109-104.
Realty Income's 9 3/8% Class B cumulative redeemable preferred stock is listed
on the NYSE under the ticker symbol "OprB" and its cusip number is 756109-302.
Realty Income's 9 1/2% Class C cumulative redeemable preferred stock is listed
on the NYSE under the ticker symbol "OprC" and its cusip number is 756109-500.
Realty Income's 8.25% Monthly Income Senior Notes, due 2008, are listed on the
NYSE under the ticker symbol "OUI". The cusip number of these notes is
756109-203.
15
Realty Income and Crest Net together had 55 employees as of August 8, 2002.
LIQUIDITY AND CAPITAL RESOURCES
CASH RESERVES. Realty Income is organized for the purpose of operating as an
equity REIT that acquires and leases properties and distributes to stockholders,
in the form of monthly cash distributions, a substantial portion of its net cash
flow generated from leases on its retail properties. We intend to retain an
appropriate amount of cash as working capital. At June 30, 2002, we had cash and
cash equivalents totaling $21.2 million.
We believe that our cash and cash equivalents on hand, cash provided from
operating activities and borrowing capacity is sufficient to meet our liquidity
needs for the foreseeable future. We intend, however, to use additional sources
of capital to fund property acquisitions and to repay our credit facilities.
CAPITAL FUNDING. We have a $200 million revolving, unsecured acquisition credit
facility that expires in December 2003. We also have a $25 million revolving,
unsecured credit facility that expires in February 2003. The credit facilities
currently bear interest at 1.225% over the London Interbank Offered Rate, or
LIBOR, and offer us other interest rate options. At August 8, 2002, we had
borrowing capacity of $132.0 million available on our credit facilities and an
outstanding balance of $92.3 million with an effective interest rate of 3.0%.
These credit facilities have been and are expected to be used to acquire
additional retail properties leased to national and regional retail chains under
long-term lease agreements. Any additional borrowings will increase our exposure
to interest rate risk. We have no mortgage debt on any of our properties.
In May 1997, we issued $110 million of 7.75% senior notes due 2007. In October
1998, we issued $100 million of 8.25% Monthly Income Senior Notes due 2008. In
January 1999, we issued $20 million of 8.0% senior notes due 2009.
In June 1999, we filed a universal shelf registration statement with the
Securities and Exchange Commission covering up to $409.2 million in value of
common stock, preferred stock and debt securities. Through August 8, 2002, we
issued $261.0 million of common stock, preferred stock and debt securities under
the universal shelf registration statement. At August 8, 2002, a balance of
$148.2 million was available under our universal shelf registration statement.
In February 2002, we issued 273,150 shares of common stock to a unit investment
trust at a net price to us of $30.26 per share, based on a 5% discount to the
market price at the time of issuance of $31.85 per share. The net proceeds of
$8.2 million were used to repay bank borrowings under our $200 million
acquisition credit facility.
In July 2002, we issued 1,550,000 shares of common stock at a price of $33.40
per share. The net proceeds of $48.8 million were used to repay borrowings under
our $200 million acquisition credit facility.
We believe that our stockholders are best served by a conservative capital
structure. Therefore, we seek to maintain a conservative debt level on our
balance sheet and solid interest and fixed charge coverage ratios. At August 8,
2002, our total outstanding credit facility borrowings and outstanding notes
were $323.0 million or approximately 20.3% of our total market capitalization of
$1.59 billion. We define our total market capitalization as the sum of the:
o Shares of our common stock outstanding multiplied by the last reported
sales price of the common stock on the NYSE on August 8, 2002 of $33.30 per
share;
o Liquidation value of the Class B Preferred Stock of $68.6 million;
o Liquidation value of the Class C Preferred Stock of $34.5 million; and
16
o Outstanding borrowings on the credit facilities and outstanding notes at
August 8, 2002.
Historically, we have met our long-term capital needs through the issuance of
common stock, preferred stock and long-term unsecured notes. Over the long term,
we believe that the majority of our future issuances of securities should be in
the form of common stock. However, we may issue additional preferred stock or
debt securities from time to time. We may issue common stock when we believe
that our share price is at a level that allows for the proceeds of any offering
to be invested on an accretive basis into additional properties. In addition, we
may issue common stock to permanently finance properties that were financed by
our credit facilities or debt securities. However, we cannot assure you that we
will have access to the capital markets at terms that are acceptable to us.
We currently are assigned investment grade corporate credit ratings on our
senior unsecured notes from Fitch Ratings, Moody's Investors Service and
Standard & Poor's Ratings Group. Currently, Fitch has assigned a rating of BBB,
Moody's has assigned a rating of Baa3 and Standard & Poor's has assigned a
rating of BBB- to our senior notes. These ratings could change based upon, among
other things, our results of operations and financial condition.
We also have received credit ratings from the same rating agencies on our
preferred stock. Fitch Ratings has assigned a rating of BBB-, Moody's Investors
Service has assigned a rating of Ba1 and Standard & Poor's Ratings Group has
assigned a rating of BB+. These ratings could change based upon, among other
things, our results of operations and financial condition.
Realty Income and its subsidiaries have no unconsolidated investments in
"special purpose entities" or off balance sheet financing, nor do we engage in
trading activities involving energy or commodity contracts or other derivative
instruments.
PROPERTY ACQUISITIONS. In the second quarter 2002, we acquired 88 properties
located in 23 states and invested $79.0 million. In the first six months of
2002, we acquired 91 properties (the "New Properties") located in 24 states and
invested $86.8 million in the New Properties and properties under development,
which includes investments of $3.0 million for properties acquired before 2002
that were under development. We have committed to pay estimated unfunded
development costs of $1.3 million on properties under construction at June 30,
2002. In the first six months of 2002, we capitalized $230,000 for re-leasing
costs and $427,000 for building improvements on existing properties in our
portfolio.
The initial weighted average annual unleveraged return on the $86.8 million
invested in 2002 is estimated to be 10.4%, computed as estimated contractual net
operating income (which in the case of a net-leased property is equal to the
base rent or, in the case of properties under construction, the estimated base
rent under the lease) for the first year of each lease, divided by the estimated
total costs. Since it is possible that a tenant could default on the payment of
contractual rent, we cannot assure you that the actual return on the funds
invested will remain at the percentage listed above.
The New Properties will contain approximately 430,700 leasable square feet and
are 100% leased under net leases, with an average initial lease term of 19.9
years. At June 30, 2002, two of the New Properties were leased and under
construction, pursuant to contracts under which the tenants agreed to develop
the properties (with development costs funded by Realty Income) with rent
scheduled to begin in the second half of 2002.
DISTRIBUTIONS. We pay monthly distributions to our common stockholders and Class
C preferred stockholders and quarterly distributions to our Class B preferred
stockholders if, as and when declared by our Board of Directors. The Class B
Preferred stockholders receive cumulative distributions at a rate of 9.375% per
annum on the $25 per share liquidation preference (equivalent to $2.34375 per
annum per share). The Class C Preferred stockholders receive cumulative
distributions at a rate of 9.5% per annum on the $25 per share liquidation
preference (equivalent to $2.375 per annum per share).
The August 2002 distribution of $0.1925 per common share represents a current
annualized distribution of $2.31 per share, and an annualized distribution yield
17
of approximately 6.9% based on the last reported sale price of $33.30 of our
common stock, on the NYSE on August 8, 2002.
In order to maintain our tax status as a REIT for federal income tax purposes,
we generally are required to distribute dividends to our stockholders
aggregating annually at least 90% of our REIT taxable income (determined without
regard to the dividends paid deduction and by excluding net capital gains) and
we are subject to income tax to the extent we distribute less than 100% of our
REIT taxable income (including net capital gains). In 2001, our distributions
totaled approximately 114.5% of our estimated REIT taxable income. Our estimated
REIT taxable income reflects non-cash deductions for depreciation and
amortization. We intend to continue to make distributions to our stockholders
that are sufficient to meet this distribution requirement and that will reduce
our exposure to income taxes. Our 2001 distributions to common stockholders were
83.4% of our 2001 funds from operations.
Our future distributions will be at the discretion of our Board of Directors and
will depend on, among other things, our results of operations, our funds from
operations, cash flow from operations, financial condition and capital
requirements, the annual distribution requirements under the REIT provisions of
the Internal Revenue Code of 1986, as amended, our debt service requirements and
any other factors the Board of Directors may deem relevant. In addition, our
credit facilities contain financial covenants which could limit the amount of
distributions payable by us in the event of a deterioration in our results of
operations or financial condition, and which prohibit the payment of
distributions on the common or preferred stock in the event that we fail to pay
when due (subject to any applicable grace period) any principal or interest on
borrowings under our credit facilities.
18
FUNDS FROM OPERATIONS ("FFO")
FFO for the second quarter of 2002 increased by $4.8 million, or 26.4%, to $23.0
million versus $18.2 million in the second quarter of 2001. FFO for the first
six months of 2002 increased by $9.6 million, or 26.8%, to $45.4 million versus
$35.8 million in the first six months of 2001.
The following is a reconciliation of net income available to common stockholders
to FFO, and information regarding distributions paid and diluted weighted
average number of common shares outstanding for the three and six months ended
June 30, 2002 and 2001 (dollars in thousands):
THREE THREE SIX SIX
MONTHS MONTHS MONTHS MONTHS
ENDED ENDED ENDED ENDED
6/30/02 6/30/01 6/30/02 6/30/01
- -------------------------------------------------------------------------------------------------------------------------------
Net income available to
common stockholders $ 16,017 $ 11,048 $ 31,883 $ 27,093
Depreciation and amortization:
Continuing operations 7,421 6,906 14,683 13,865
Discontinued operations 218 252 460 503
Depreciation of furniture, fixtures
and equipment (34) (28) (67) (56)
Provision for impairment losses:
Continuing operations -- 200 -- 530
Discontinued operations 670 -- 830 --
Gain on sales of investment properties:
Continuing operations -- (164) (340) (6,115)
Discontinued operations (1,305) -- (2,079) --
- -------------------------------------------------------------------------------------------------------------------------------
Total funds from operations $ 22,987 $ 18,214 $ 45,370 $ 35,820
===============================================================================================================================
Distributions paid to common stockholders $ 19,114 $ 15,419 $ 37,934 $ 30,189
FFO in excess of distributions paid
to common stockholders $ 3,873 $ 2,795 $ 7,436 $ 5,631
Diluted weighted average number of
common shares outstanding 33,368,359 28,468,992 33,230,817 27,565,500
We define FFO, consistent with the National Association of Real Estate
Investment Trust's definition, as net income available to common stockholders,
plus depreciation and amortization of assets uniquely significant to the real
estate industry, reduced by gains and increased by losses on (i) sales of
investment property and provisions for impairment and (ii) extraordinary items.
19
ADJUSTED FUNDS FROM OPERATIONS
Adjusted FFO for the second quarter of 2002 increased by $4.6 million, or 24.9%,
to $23.1 million versus $18.5 million in the second quarter of 2001. Adjusted
FFO for the first six months of 2002 increased by $9.2 million, or 25.4%, to
$45.4 million versus $36.2 million in the first six months of 2001.
The following is a reconciliation of FFO to adjusted FFO for the three and six
months ended June 30, 2002 and 2001. The adjustments are for non-cash items and
capitalized expenditures on existing properties in our portfolio (dollars in
thousands):
THREE THREE SIX SIX
MONTHS MONTHS MONTHS MONTHS
ENDED ENDED ENDED ENDED
6/30/02 6/30/01 6/30/02 6/30/01
- -------------------------------------------------------------------------------------------------------------------------------
Funds from operations $ 22,987 $ 18,214 $ 45,370 $ 35,820
Amortization of settlements on
treasury lock agreements 189 189 378 378
Amortization of deferred financing costs 242 237 479 485
Amortization of stock compensation 152 78 284 145
Capitalized leasing costs and commissions (76) (65) (230) (226)
Capitalized building improvements (405) (101) (427) (245)
Straight-line rent (21) (97) (418) (123)
- -------------------------------------------------------------------------------------------------------------------------------
Total adjusted funds from operations $ 23,068 $ 18,455 $ 45,436 $ 36,234
===============================================================================================================================
Diluted weighted average number of
common shares outstanding 33,368,359 28,468,992 33,230,817 27,565,500
We consider FFO and adjusted FFO to be appropriate measures of the performance
of equity REITs. Financial analysts use FFO and adjusted FFO in evaluating
REITs. FFO and adjusted FFO can be a way to measure a REIT's ability to make
cash distribution payments. Presentation of this information is intended to
assist the reader in comparing the performance of different REITs, although it
should be noted that not all REITs calculate FFO and adjusted FFO the same way;
therefore, comparisons with other REITs may not be meaningful.
FFO and adjusted FFO are not necessarily indicative of cash flow available to
fund cash needs and should not be considered as an alternative to net income as
an indication of Realty Income's performance. In addition, FFO and adjusted FFO
should not be considered as an alternative to reviewing our cash flows from
operating, investing and financing activities as a measure of our liquidity, our
ability to make cash distributions or our ability to pay interest payments.
20
FFO GENERATED BY CREST NET LEASE
Crest Net generated $901,000 in FFO for Realty Income during the second quarter
of 2002 and $141,000 during the second quarter of 2001. Crest Net generated $1.3
million in FFO for Realty Income during the first six months of 2002 and 2001.
The following is a calculation of the FFO generated by Crest Net in the second
quarter and first six month of 2002 and 2001 (dollars in thousands):
THREE THREE SIX SIX
MONTHS MONTHS MONTHS MONTHS
ENDED ENDED ENDED ENDED
6/30/02 6/30/01 6/30/02 6/30/01
- -------------------------------------------------------------------------------------------------------------------------------
Gains from the sales of real estate
acquired for resale $ 1,126 $ 161 $ 1,491 $ 2,089
Rent and other revenue 481 354 956 786
Interest expense (144) (171) (219) (454)
General and administrative expenses (88) (73) (284) (278)
Property expenses -- -- (42) --
Income taxes (474) (127) (638) (784)
Minority interest -- (3) -- (56)
- -------------------------------------------------------------------------------------------------------------------------------
Total adjusted funds from operations $ 901 $ 141 $ 1,264 $ 1,303
===============================================================================================================================
Diluted weighted average number of
common shares outstanding 33,368,359 28,468,992 33,230,817 27,565,500
RESULTS OF OPERATIONS
THE FOLLOWING IS A COMPARISON OF OUR RESULTS OF OPERATIONS FOR THE THREE AND SIX
MONTHS ENDED JUNE 30, 2002 TO THE THREE AND SIX MONTHS ENDED JUNE 30, 2001.
RENTAL REVENUE was $32.7 million for the second quarter of 2002 versus $28.6
million for the second quarter of 2001, an increase of $4.1 million, or 14.3%.
The increase in rental revenue is attributable to:
o The properties acquired in the first six months of 2002, which generated
revenue of $707,000 in the second quarter of 2002;
o The properties acquired in 2001, which generated revenue of $3.5 million in
the second quarter of 2002 compared to $99,000 in the second quarter of
2001, an increase of $3.4 million;
o Same store rents generated on 951 leased properties owned in all of both
the second quarters of 2002 and 2001 increased by $416,000, or 1.5%, to
$27.32 million from $26.91 million;
o Properties owned by Crest Net, which generated revenue of $481,000 in the
second quarter of 2002 compared to $354,000 in the second quarter of 2001,
an increase of $127,000;
o Properties sold during 2001 and 2002, which generated revenue of $7,000 in
the second quarter of 2002 as compared to $472,000 in the second quarter of
2001, a decrease of $465,000;
o Development properties acquired before 2001 that started paying rent in
2001, properties that were vacant during part of 2001 or 2002 and lease
termination settlements, which generated revenue of $687,000 in the second
quarter of 2002 compared to $622,000 in the same quarter of 2001, an
increase of $65,000; and
o Straight-line rent of $21,000 in the second quarter of 2002 as compared to
$97,000 in the second quarter of 2001, a decrease of $76,000.
21
RENTAL REVENUE was $65.2 million for the first six months of 2002 versus $57.0
million for the first six months of 2001, an increase of $8.2 million, or 14.4%.
The increase in rental revenue is attributable to:
o The properties acquired in the first six months of 2002, which generated
revenue of $765,000 in the first six months of 2002;
o The properties acquired in 2001, which generated revenue of $6.9 million in
the first six months of 2002 compared to $140,000 in the first six months
of 2001, an increase of $6.8 million;
o Same store rents generated on 951 leased properties owned in all of both
2002 and 2001 increased by $990,000, or 1.8%, to $54.75 million from $53.76
million;
o Properties owned by Crest Net, which generated revenue of $956,000 in the
first six months of 2002 compared to $786,000 in the first six months of
2001, an increase of $170,000;
o Properties sold during 2001 and 2002, which generated revenue of $40,000 in
the first six months of 2002 as compared to $1.3 million in the first six
months of 2001, a decrease of $1.2 million;
o Development properties acquired before 2001 that started paying rent in
2001, properties that were vacant during part of 2001 or 2002 and lease
termination settlements, which generated revenue of $1.3 million in the
first six months of 2002 compared to $937,000 in the same period of 2001,
an increase of $358,000; and
o Straight-line rent of $418,000 in the first six months of 2002 as compared
to $123,000 in the first six months of 2001, an increase of $295,000.
Of the 1,199 properties in the portfolio as of June 30, 2002, 1,194 are
single-tenant properties with the remaining properties being multi-tenant
properties. Of the 1,194 single-tenant properties, 1,175, or 98.4%, were net
leased with a weighted average remaining lease term (excluding extension
options) of approximately 10.7 years at June 30, 2002. Of our 1,194 leased
single-tenant properties, 1,179 or 98.7% were under leases that provide for
increases in rents through:
o Base rent increases tied to a consumer price index with adjustment
ceilings;
o Overage rent based on a percentage of the tenants' gross sales;
o Fixed increases; or
o A combination of two or more of the above rent provisions.
Percentage rent, which is included in rental revenue during the second quarter
of 2002 and 2001, was $66,000 and $87,000, respectively. Percentage rent, which
is included in rental revenue during the first six months of 2002 and 2001, was
$209,000 and $206,000, respectively.
Our portfolio of retail real estate owned under net leases continues to perform
well and provides dependable lease revenue supporting the payment of our monthly
dividends. As of June 30, 2002, our portfolio of 1,199 retail properties was
98.4% leased with 19 properties available for lease.
Transactions to lease or sell eight of the 19 properties not leased at June 30,
2002 were underway or completed as of August 2, 2002. We anticipate these
transactions to be completed during the next six months; although we cannot
guarantee that all of these properties can be sold or leased within this period.
GAIN ON SALES OF REAL ESTATE ACQUIRED FOR RESALE. During the second quarter of
2002, Crest Net sold eight properties for $9.0 million and we recognized a gain
on the sales of $1.1 million, before income taxes. During the second quarter of
2001, Crest Net sold one property for $1.5 million and we recognized a gain on
the sale of $161,000, before income taxes.
During the first six months of 2002, Crest Net sold 11 properties for $11.7
million and we recognized a gain on the sales of $1.5 million, before income
taxes. During the first six months of 2001, Crest Net sold five properties for
$15.5 million and we recognized a gain on the sales of $2.1 million, before
income taxes.
At June 30, 2002, Crest Net had $15.9 million invested in 15 properties, which
are held for sale. It is anticipated that Crest Net will carry an average
22
inventory of $20 to $25 million in real estate. Crest Net generates an earnings
spread on the differential between the lease payments it receives and the cost
of capital used to acquire the properties. It is our belief, and it has been our
experience to date, that at this level of inventory, these earnings will more
than cover the ongoing operating expenses of Crest Net.
INTEREST EXPENSE. The following is a summary of the five components of interest
expense for the three months ended June 30, 2002 and 2001 (dollars in
thousands):
THREE MONTHS ENDED JUNE 30, 2002 2001 NET CHANGE
- ----------------------------------------------------------------------------------------------------------------------
Interest on outstanding loans and notes $ 5,286 $ 6,108 $ (822)
Amortization of settlements on treasury lock agreements 189 189 --
Credit facility commitment fees 128 128 --
Amortization of credit facility origination costs and deferred
bond financing costs 280 273 7
Interest capitalized (80) (111) 31
- ----------------------------------------------------------------------------------------------------------------------
Interest expense $ 5,803 $ 6,587 $ (784)
======================================================================================================================
Credit facility and notes outstanding
THREE MONTHS ENDED JUNE 30, 2002 2001 Net Change
- ----------------------------------------------------------------------------------------------------------------------
$ 320,474 $ 326,148 $ (5,674)
Average outstanding balances (in thousands)
Average interest rates 6.62% 7.51% (0.89)%
Interest on outstanding loans and notes decreased by $822,000 in the second
quarter of 2002 as compared to the second quarter of 2001 primarily due to a
decrease of 89 basis points in our average interest rates. In 2001, the Federal
Reserve decreased the federal funds rate 11 times by an aggregate total of 475
basis points. Correspondingly, the average borrowing rate on our credit
facilities has declined during the same period. The average interest rate on our
credit facilities decreased to 3.07% in the second quarter of 2002 from 6.31% in
the second quarter of 2001. The majority of the interest rate reductions on our
credit facilities in 2001 occurred during the second half of 2001.
The following is a summary of the five components of interest expense for the
six months ended June 30, 2002 and 2001 (dollars in thousands):
SIX MONTHS ENDED JUNE 30, 2002 2001 NET CHANGE
- ----------------------------------------------------------------------------------------------------------------------
Interest on outstanding loans and notes $ 10,474 $ 13,641 $ (3,167)
Amortization of settlements on treasury lock agreements 378 378 --
Credit facility commitment fees 256 257 (1)
Amortization of credit facility origination costs and deferred
bond financing costs 556 557 (1)
Interest capitalized (256) (187) (69)
- ----------------------------------------------------------------------------------------------------------------------
Interest expense $ 11,408 $ 14,646 $ (3,238)
================================================================= ================== =============== =================
Credit facility and notes outstanding
SIX MONTHS ENDED JUNE 30, 2002 2001 NET CHANGE
- ----------------------------------------------------------------------------------------------------------------------
$ 314,816 $ 357,023 $ (42,207)
Average outstanding balances (in thousands)
Average interest rates 6.71% 7.71% (1.00)%
Interest on outstanding loans and notes decreased by $3.2 million in the first
six months of 2002 as compared to the first six months of 2001 due to a decrease
23
of $42.2 million in the average outstanding balances and a decrease of 100 basis
points in our average interest rates. The average interest rate on our credit
facilities decreased to 3.06% in the first six months of 2002 from 7.07% in the
first six months of 2001.
At August 8, 2002, the weighted average interest rate on our:
o Credit facility borrowings of $93.0 million was 2.98%;
o Notes payable of $230 million was 7.99%; and
o Combined outstanding credit facilities and notes of $323.0 million was
6.55%.
Our interest coverage ratio for the six months ended June 30, 2002 and 2001 was
5.5 times and 3.9 times, respectively. Interest coverage ratio is calculated as
follows: EBITDA divided by interest expense. EBITDA is calculated as follows:
net income plus interest expense, income taxes, depreciation, amortization and
impairment losses less gain on sales of investment properties. Our EBITDA for
the six months ended June 30, 2002 and 2001 was $62.6 million and $56.4 million,
respectively. This information should not be considered as an alternative to any
measure of performance as promulgated under GAAP. Our calculation of EBITDA may
be different from the calculation used by other companies and, therefore,
comparability may be limited.
Our fixed coverage ratio for the six months ended June 30, 2002 and 2001 was 3.8
times and 2.9 times, respectively. Fixed coverage ratio is calculated as
follows: EBITDA divided by the sum of interest expense and preferred stock
dividends. This information should not be considered as an alternative to any
measure of performance as promulgated under GAAP.
DEPRECIATION AND AMORTIZATION was $7.4 million in the second quarter of 2002
versus $6.9 million in the second quarter of 2001. Depreciation and amortization
was $14.7 million in the first six months of 2002 versus $13.9 million in the
first six months of 2001. The increase in 2002 was primarily due to the
acquisition of properties during 2001. Depreciation of buildings and
improvements is computed using the straight-line method over an estimated useful
life of 25 years. If we used a shorter or longer estimated useful life it could
have a material impact on our results of operations and financial position. We
believe that 25 years is an appropriate estimate of useful life. No depreciation
has been recorded on Crest Net's properties because they are held for sale.
Amortization of goodwill for the second quarter and six months ended of 2001 was
$231,000 and $462,000, respectively. In accordance with Statement of Financial
Accounting Standards No. 142, "Goodwill and Other Intangible Assets," effective
January 2002, our goodwill is no longer amortized, but instead will be tested
for impairment at least annually. If goodwill is determined to be impaired, a
provision for impairment will be recorded to reduce the carrying value to its
fair value. During the second quarter of 2002, we completed the transitional
impairment testing of our goodwill and found that our goodwill was not impaired.
GENERAL AND ADMINISTRATIVE EXPENSES increased by $482,000 to $2.3 million in the
second quarter of 2002 versus $1.9 million in the same quarter of 2001. General
and administrative expenses as a percentage of revenue increased to 6.9% in the
second quarter of 2002 as compared to 6.5% in the same quarter of 2001. General
and administrative expenses increased primarily due to an increase in employees
and employee related costs. Realty Income and Crest Net had 55 employees at
August 8, 2002 as compared to 48 employees at the beginning of 2001. This
increase in staffing was largely due to an increase in our legal and portfolio
management departments due to the increase in the size and maturity of our
portfolio. We feel our current staffing levels are sufficient to meet the needs
of the company. We do not anticipate the number of employees to increase over
the next several quarters. To a lesser extent, general and administrative
expenses also increased due to increases in insurance costs and property
acquisition costs.
General and administrative expenses increased by $831,000 to $4.7 million in the
first six months of 2002 versus $3.9 million in the first six months of 2001.
General and administrative expenses as a percentage of revenue increased to 7.1%
in 2002 as compared to 6.6% in 2001. General and administrative expenses
increased due to reasons stated above.
24
PROPERTY EXPENSES are broken down into costs associated with non-net leased
multi-tenant properties, unleased single-tenant properties and general portfolio
expenses. Expenses related to the multi-tenant and unleased single-tenant
properties include, but are not limited to, property taxes, maintenance,
insurance, utilities, property inspections, bad debt expense and legal fees.
General portfolio costs include, but are not limited to, insurance, legal,
property inspections and title search fees. At June 30, 2002, 19 properties were
available for lease, as compared to 20 at December 31, 2001 and 23 at June 30,
2001.
Property expenses were $622,000 in the second quarter of 2002 and $556,000 in
the second quarter of 2001. The $66,000 increase in property expenses is
primarily attributable to an increase in portfolio property insurance and costs
associated with the properties available for lease. Property expenses were $1.2
million in both the first six months of 2002 and the first six months of 2001.
OTHER EXPENSES increased $358,000 to $598,000 in the second quarter of 2002
versus $240,000 in the second quarter of 2001. The increase in 2002 is primarily
due to an increase in Crest Net income taxes of $347,000. Crest Net taxes were
higher because its net income was higher.
The following is a summary of our other expenses for the three months ended June
30, 2002 and 2001 (dollars in thousands):
THREE MONTHS ENDED JUNE 30, 2002 2001 NET CHANGE
- ----------------------------------------------------------------------------------------------------------------------
Realty Income's state and local income taxes $ 124 $ 113 $ 11
Crest Net's income taxes 474 127 347
- ----------------------------------------------------------------------------------------------------------------------
Other expenses $ 598 $ 240 $ 358
======================================================================================================================
Other expenses decreased $134,000 to $886,000 in the first six months of 2002
versus $1.0 million in the first six months of 2001. The decrease in 2002 is
primarily due to a decrease in Crest Net income taxes of $144,000. Crest Net
taxes were lower because its net income was lower.
The following is a summary of our other expenses for the six months ended June
30, 2002 and 2001 (dollars in thousands):
SIX MONTHS ENDED JUNE 30, 2002 2001 NET CHANGE
- ----------------------------------------------------------------------------------------------------------------------
Realty Income's state and local income taxes $ 248 $ 236 $ 12
Crest Net's income taxes 638 784 (146)
- ----------------------------------------------------------------------------------------------------------------------
Other expenses $ 886 $1,020 $ (134)
======================================================================================================================
A PROVISION FOR IMPAIRMENT LOSS of $200,000 and $530,000 was recorded in the
second quarter and first six months of 2001, respectively. A provision for
impairment loss of $670,000 and $830,000 was recorded in the second quarter and
first six months of 2002, respectively, and is included in discontinued
operations. We review long-lived assets for impairment whenever events or
changes in circumstances indicate that the carrying amount of the asset may not
be recoverable. Generally, a provision is made for impairment loss if estimated
future operating cash flows (undiscounted and without interest charges) plus
estimated disposition proceeds (undiscounted) are less than the current book
value. Impairment losses are measured as the amount by which the current book
value of the asset exceeds the fair value of the asset. The carrying value of
our real estate is the largest component of our consolidated balance sheet. If
events should occur that required us to reduce the carrying value of our real
estate by recording provisions for impairment losses, it could have a material
impact on our results of operations or financial position.
INCOME FROM DISCONTINUED OPERATIONS. In August 2001, the Financial Accounting
Standards Board issued Statement No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets. Effective January 1, 2002, Statement No. 144
superseded Statement No. 121, Accounting for the Impairment of Long-Lived Assets
and for Long-Lived Assets to be Disposed Of. Statement No. 144 requires
long-lived assets to be disposed of to be measured at the lower of carrying
25
amount or fair value less cost to sell on our balance sheet. It also broadened
the reporting requirements of discontinued operations to include a component of
an entity rather than a segment of a business. Statement No. 144 states that a
component of an entity comprises operations and cash flows that clearly can be
distinguished, operationally and for financial reporting purposes, from the rest
of the entity. In accordance with Statement No. 144, we report each individual
property as a reporting component for determining discontinued operations.
Thirty four properties listed as held for sale at June 30, 2002, plus three
properties sold during the first quarter of 2002 and 10 properties sold during
the second quarter 2002 were reported as discontinued operations. As required by
Statement No. 144, three other properties reported as held for sale at December
31, 2001, that were sold during 2002, were not reported as discontinued
operations. The following is a summary of our income from discontinued
operations for the three and six months ended June 30, 2002 and 2001 (dollars in
thousands):
THREE THREE SIX SIX
MONTHS MONTHS MONTHS MONTHS
ENDED ENDED ENDED ENDED
6/30/02 6/30/01 6/30/02 6/30/01
------------------------------------------------------------------------------------------------------------------
Rental revenue $ 963 $ 1,035 $ 1,923 $ 2,058
Interest and other revenue -- -- -- 14
Gain on sales of investment properties 1,305 -- 2,079 --
Depreciation and amortization (218) (252) (460) (503)
Property expenses (44) (8) (90) (24)
Provision for impairment loss (670) -- (830) --
------------------------------------------------------------------------------------------------------------------
Income from discontinued operations $ 1,336 $ 775 $ 2,622 $ 1,545
==================================================================================================================
GAIN ON SALES OF INVESTMENT PROPERTIES. During the second quarter of 2002, we
sold 10 investment properties for $3.8 million and recognized a gain of $1.3
million which is included in income from discontinued operations. During the
second quarter of 2001, we sold three investment properties for $2.6 million and
recognized a gain of $164,000.
During the first six months of 2002, we sold 16 investment properties for $7.2
million and recognized a gain of $2.4 million. Of this gain, $2.1 million is
included in income from discontinued operations. During the first six months of
2001, we sold 13 investment properties for $19.7 million and recognized a gain
of $6.1 million.
We have an active portfolio management program that incorporates the sale of
assets when we believe the reinvestment of the sale proceeds will generate
higher returns, enhance the credit quality of our real estate portfolio or
extend our average remaining lease term. At June 30, 2002, we classified real
estate with a carrying amount of $32.7 million as held for sale, which includes
$15.9 million in properties owned by Crest Net. Additionally, we anticipate
selling properties from our portfolio that have not yet been specifically
identified. We anticipate we will receive up to $50 million in proceeds from the
sale of properties during the next 12 months. We intend to invest these proceeds
into new property acquisitions.
PREFERRED STOCK DIVIDENDS. We declared preferred stock dividends of $2.4 million
in both the second quarters of 2002 and 2001 and $4.9 million in both the first
six months of 2002 and 2001.
26
NET INCOME AVAILABLE TO COMMON STOCKHOLDERS was $16.0 million in the second
quarter of 2002 and $11.0 million in the second quarter of 2001, an increase of
$5.0 million. Net income available to common stockholders was $31.9 million in
the first six months of 2002 and $27.1 million in the first six months of 2001,
an increase of $4.8 million.
The calculation to determine net income available to common stockholders
includes gains and losses from the sale of investment properties some of which
is included in income from discontinued operations. The amount of gains and
losses vary from period to period based on the timing of property sales and can
significantly impact net income available to common stockholders.
The gain recognized from property sales during the second quarter of 2002 was
$1.3 million. This was $1.1 million more than the gain recognized from property
sales during the second quarter of 2001. Excluding the gain on sales of
properties, net income available to common stockholders increased by $3.8
million, or 35.2%.
The gain recognized from property sales during the first six months of 2002 was
$2.4 million. This was $3.7 million less than the gain recognized from property
sales during the first six months of 2001. Excluding the gain on sales of
properties, net income available to common stockholders increased by $8.5
million, or 40.5%.
PROPERTIES
As of June 30, 2002, we owned a diversified portfolio:
o Of 1,199 properties;
o With an occupancy rate of 98.4%, or 1,180 of the 1,199 properties;
o Leased to 81 different retail chains;
o Doing business in 24 separate retail industries;
o Located in 48 states;
o With over 9.8 million square feet of leasable space; and
o With an average leasable retail space of 8,200 square feet on approximately
62,000 square feet of land.
In addition to our real estate portfolio, at June 30, 2002 our subsidiary, Crest
Net, owned a portfolio of 15 properties and had invested $15.9 million.
At June 30, 2002, 1,175 or 98.0% of the 1,199 properties were leased under
net-lease agreements. Net leases typically require the tenant to be responsible
for minimum monthly rent and property operating expenses including property
taxes, insurance and maintenance. In addition, tenants are typically responsible
for future rent increases (generally subject to ceilings) based on increases in
the consumer price index, fixed increases or additional rent calculated as a
percentage of the tenants' gross sales above a specified level.
Our net-leased retail properties are primarily leased to regional and national
retail chain store operators. Generally, buildings are single-story properties
with adequate parking on site to accommodate peak retail traffic periods. The
properties tend to be on major thoroughfares with relatively high traffic counts
and adequate access, egress and proximity to a sufficient population base to
constitute a suitable market or trade area for the retailer's business.
27
The following table sets forth certain information regarding our properties
classified according to the business of the respective tenants, expressed as a
percentage of our total rental revenue.
PERCENTAGE OF RENTAL REVENUE (1)
----------------------------------------------------------------------------------------
ANNUALIZED FOR THE YEARS ENDED DECEMBER 31,
RENT AS OF ---------------------------------------------------------------------
JUNE 30,
INDUSTRY 2002(2) 2001 2000 1999 1998 1997 1996
- -------------------------------------------------------------------------------------------------------------------------
Apparel stores 2.2% 2.4% 2.4% 3.8% 4.1% 0.7% --%
Automotive parts 7.5 8.3 8.3 8.6 7.8 9.1 10.5
Automotive service 8.1 5.7 5.8 6.6 7.5 6.4 4.8
Book stores 0.4 0.4 0.5 0.5 0.6 0.5 --
Business services 0.1 0.1 0.1 0.1 * -- --
Child care 20.4 23.9 24.7 25.3 29.2 35.9 42.0
Consumer electronics 3.3 4.0 4.9 4.4 5.4 6.5 0.9
Convenience stores 9.6 8.4 8.4 7.2 6.1 5.5 4.6
Crafts and novelties 0.4 0.4 0.4 0.4 * -- --
Drug stores 0.2 0.2 0.2 0.2 0.1 -- --
Entertainment 1.8 1.8 2.0 1.2 -- -- --
General merchandise 0.5 0.6 0.6 0.6 * -- --
Grocery stores 0.5 0.6 0.6 0.5 * -- --
Health and fitness 3.9 3.6 2.4 0.6 0.1 -- --
Home furnishings 5.5 6.0 5.8 6.5 7.8 5.6 4.4
Home improvement 1.1 1.3 2.0 3.6 * -- --
Office supplies 2.0 2.2 2.3 2.6 3.0 1.7 --
Pet supplies and services 1.7 1.6 1.5 1.1 0.6 0.2 --
Private education 1.2 1.5 1.4 1.2 0.9 -- --
Restaurants 13.4 12.2 12.3 13.3 16.2 19.8 24.4
Shoe stores 0.9 0.7 0.8 1.1 0.8 0.2 --
Sporting goods 4.0 0.9 -- -- -- -- --
Theaters 3.7 4.3 2.7 0.6 -- -- --
Video rental 3.3 3.7 3.9 4.3 3.8 0.6 --
Other 4.3 5.2 6.0 5.7 6.0 7.3 8.4
- -------------------------------------------------------------------------------------------------------------------------
Totals 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
=========================================================================================================================
* Less than 0.1%
(1) Does not include properties owned by our subsidiary, Crest Net Lease.
(2) Annualized rent is calculated by multiplying the monthly contractual base
rent as of June 30, 2002 for each of the properties by 12 and adding the
previous 12 month's historic percentage rent on properties owned at June 30,
2002, which totaled $1.7 million (i.e., additional rent calculated as a
percentage of the tenants' gross sales above a specified level). For the
properties under construction, an estimated contractual base rent is used based
upon the estimated total costs of each property.
28
The following table sets forth certain information regarding the properties
owned by Realty Income at June 30, 2002, classified according to the retail
business types and the level of services they provide (dollars in thousands):
NUMBER OF ANNUALIZED PERCENTAGE OF
INDUSTRY PROPERTIES(1) RENT(1)(2) ANNUALIZED RENT
- -----------------------------------------------------------------------------------------------------------------------
Tenants Providing Services
Automotive service 176 $ 11,533 8.2%
Child care 320 28,618 20.4
Entertainment 8 2,564 1.8
Health and fitness 8 5,455 3.9
Private education 5 1,738 1.3
Theaters 10 5,209 3.7
Other 8 6,021 4.3
---------------------------------------------------------------------------------
535 61,138 43.6
---------------------------------------------------------------------------------
Tenants Selling Goods and Services
Automotive parts (with installation) 65 6,066 4.3
Business services 1 124 0.1
Convenience stores 114 13,545 9.6
Home improvement 2 187 0.1
Pet supplies and services 6 1,561 1.1
Restaurants 223 18,752 13.4
Video rental 34 4,577 3.3
---------------------------------------------------------------------------------
445 44,812 31.9
---------------------------------------------------------------------------------
Tenants Selling Goods
Apparel stores 5 3,103 2.2
Automotive parts 75 4,347 3.1
Book stores 2 606 0.4
Consumer electronics 36 4,660 3.3
Crafts and novelties 2 517 0.4
Drug stores 1 235 0.2
General merchandise 11 687 0.5
Grocery stores 2 726 0.5
Home furnishings 43 7,737 5.5
Home improvement 13 1,377 1.0
Office supplies 9 2,846 2.0
Pet supplies 4 761 0.5
Shoe stores 5 1,221 0.9
Sporting goods 11 5,584 4.0
- -----------------------------------------------------------------------------------------------------------------------
219 34,407 24.5
- -----------------------------------------------------------------------------------------------------------------------
TOTALS 1,199 $ 140,357 100.0%
=======================================================================================================================
(1) This table does not include properties owned by our subsidiary, Crest Net
Lease.
(2) Annualized rent is calculated by multiplying the monthly contractual base
rent as of June 30, 2002 for each of the properties by 12 and adding the
previous 12 month's historic percentage rent on properties owned at June 30,
2002, which totaled $1.7 million (i.e., additional rent calculated as a
percentage of the tenants' gross sales above a specified level). For the
properties under construction, an estimated contractual base rent is used based
upon the estimated total costs of each property.
29
Of the 1,199 properties in the portfolio at June 30, 2002, 1,194 were
single-tenant properties with the remaining properties being multi-tenant
properties. At June 30, 2002, 1,175 of the 1,194 single-tenant properties, or
98.4%, were net leased with a weighted average remaining lease term (excluding
extension options) of approximately 10.7 years.
The following table sets forth certain information regarding the timing of the
initial lease term expirations (excluding extension options) on our 1,175
net-leased, single-tenant retail properties at June 30, 2002 (dollars in
thousands):
NUMBER OF ANNUALIZED PERCENTAGE OF
YEAR LEASES EXPIRING(1) RENT(1)(2) ANNUALIZED RENT
- ----------------------------------------------------------------------------------------------------------------
2002 71 $ 6,231 4.6%
2003 79 6,797 5.0
2004 116 10,013 7.4
2005 84 6,619 4.9
2006 75 6,740 5.0
2007 94 6,541 4.9
2008 63 5,673 4.2
2009 28 2,526 1.9
2010 43 3,812 2.8
2011 35 5,312 3.9
2012 50 5,995 4.4
2013 70 12,348 9.2
2014 35 6,287 4.7
2015 35 4,186 3.1
2016 14 1,497 1.1
2017 14 4,691 3.5
2018 16 1,988 1.5
2019 49 8,246 6.1
2020 10 3,664 2.7
2021 96 14,746 10.9
2022 89 8,244 6.1
2023 2 341 0.3
2026 2 372 0.3
2033 2 1,118 0.8
2034 3 879 0.7
- ----------------------------------------------------------------------------------------------------------------
Totals 1,175 $ 134,866 100.0%
================================================================================================================
(1) This table does not include five multi-tenant properties and 19 vacant,
unleased single-tenant properties owned by the Company and properties owned by
our subsidiary, Crest Net Lease. The lease expirations for properties under
construction are based on the estimated date of completion of such properties.
(2) Annualized rent is calculated by multiplying the monthly contractual base
rent as of June 30, 2002 for each of the properties by 12 and adding the
previous 12 month's historic percentage rent on properties owned at June 30,
2002, which totaled $1.7 million (i.e., additional rent calculated as a
percentage of the tenants' gross sales above a specified level). For the
properties under construction, an estimated contractual base rent is used based
upon the estimated total costs of each property. The following table sets forth
certain state-by-state information regarding Realty Income's property portfolio
as of June 30, 2002 (dollars in thousands):
30
Approximate Percentage of
Number of Percent Leasable Annualized Annualized Rent
State Properties(1) Leased Square Feet Rent(1)(2)
- ------------------------------------------------------------------------------------------------------------------
Alabama 15 93% 142,600 $ 1,391 1.0%
Alaska 2 100 128,500 1,003 0.7
Arizona 35 97 248,800 3,947 2.8
Arkansas 8 100 48,800 916 0.7
California 61 98 1,024,200 14,496 10.3
Colorado 44 100 272,400 4,235 3.0
Connecticut 16 100 245,600 3,705 2.6
Delaware 1 100 5,400 72 0.1
Florida 92 95 1,163,500 15,223 10.8
Georgia 67 99 466,800 6,611 4.7
Idaho 11 100 52,000 770 0.5
Illinois 41 100 322,200 4,547 3.2
Indiana 30 97 169,500 2,172 1.5
Iowa 10 100 67,600 702 0.5
Kansas 21 100 190,000 2,209 1.6
Kentucky 13 100 43,600 1,157 0.8
Louisiana 7 100 47,100 723 0.5
Maryland 14 100 113,700 2,369 1.7
Massachusetts 30 100 138,300 2,897 2.1
Michigan 14 100 87,300 1,245 0.9
Minnesota 22 95 237,300 2,239 1.6
Mississippi 22 95 181,000 1,708 1.2
Missouri 35 100 230,400 3,001 2.1
Montana 2 100 30,000 305 0.2
Nebraska 10 100 91,200 1,211 0.9
Nevada 10 100 100,700 1,593 1.1
New Hampshire 6 100 23,900 593 0.4
New Jersey 22 100 106,100 3,470 2.5
New Mexico 5 100 46,000 361 0.3
New York 24 100 265,600 5,648 4.0
North Carolina 36 100 181,400 3,454 2.5
North Dakota 1 100 22,000 65 *
Ohio 65 95 365,800 5,418 3.9
Oklahoma 19 100 107,600 1,537 1.1
Oregon 17 100 202,100 1,887 1.3
Pennsylvania 32 100 251,200 3,597 2.6
Rhode Island 1 100 3,500 116 0.1
South Carolina 47 100 142,000 4,035 2.9
South Dakota 2 100 12,600 176 0.1
Tennessee 33 100 248,800 3,342 2.4
Texas 153 97 1,208,600 14,158 10.1
Utah 7 100 43,300 645 0.5
Vermont 1 100 2,500 87 0.1
Virginia 32 100 314,400 5,697 4.1
Washington 40 100 261,800 3,216 2.3
West Virginia 2 100 16,800 161 0.1
Wisconsin 17 100 168,400 1,976 1.4
Wyoming 4 100 20,100 271 0.2
- ------------------------------------------------------------------------------------------------------------------
Totals/Average 1,199 98% 9,863,000 $ 140,357 100.0%
==================================================================================================================
* Less than 0.1%
(1) Does not include properties owned by our subsidiary, Crest Net Lease.
(2) Annualized rent is calculated by multiplying the monthly contractual base
rent as of June 30, 2002 for each of the properties by 12 and adding the
31
previous 12 month's historic percentage rent on properties owned at June 30,
2002, which totaled $1.7 million (i.e., additional rent calculated as a
percentage of the tenants' gross sales above a specified level). For the
properties under construction, an estimated contractual base rent is used based
upon the estimated total costs of each property.
IMPACT OF INFLATION
Tenant leases generally provide for limited increases in rent as a result of
increases in the tenants' sales volumes, increases in the consumer price index,
and/or fixed increases. We expect that inflation will cause these lease
provisions to result in increases in rent over time. During times when inflation
is greater than increases in rent as provided for in the leases, rent increases
may not keep up with the rate of inflation.
Approximately 98.0% or 1,175 of the 1,199 properties in the portfolio are leased
to tenants under net leases where the tenant is responsible for property costs
and expenses. These lease features reduce our exposure to rising property
expenses due to inflation. Inflation and increased costs may have an adverse
impact on our tenants if increases in their operating expenses exceed increases
in revenue.
IMPACT OF ACCOUNTING PRONOUNCEMENTS
A. In June 2001, the Financial Accounting Standards Board ("FASB") issued
Statement No. 142, Goodwill and Other Intangible Assets. Statement No. 142
requires that goodwill and intangible assets with indefinite useful lives no
longer be amortized, but instead tested for impairment at least annually in
accordance with the provisions of Statement No. 142. Statement No. 142 also
requires that intangible assets with definite useful lives be amortized over
their respective estimated useful lives to their estimated residual values, and
reviewed for impairment in accordance with FASB Statement No. 121, Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed
of.
The Company adopted Statement No. 142 effective January 1, 2002. At the date of
adoption, the Company had unamortized goodwill in the amount of $17.2 million.
Amortization expense related to goodwill was $231,000 and $462,000 during second
quarter and first six months of 2001, respectively. The Company does not have
any intangible assets or unamortized negative goodwill. As required by Statement
No. 142, we applied our goodwill to the relevant "reporting units" which were
determined to be the seven industry segments we had investments in at the time
the goodwill originated. During the second quarter of 2002, we completed the
transitional impairment testing of our goodwill and found that our goodwill was
not impaired.
B. In August 2001, the FASB issued Statement No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets. Statement No. 144 will supersede
Statement No. 121, Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed Of. Statement No. 144 requires long-lived
assets to be disposed of to be measured at the lower of carrying amount or fair
value less cost to sell on our balance sheet. The Company adopted the provisions
of Statement No. 144 on January 1, 2002. The adoption of Statement No. 144 has
not had a material effect on our financial position, results of operations or
liquidity.
C. In July 2002, we changed our method of accounting for stock-based
compensation to the fair value based method which is the preferred method of
accounting as provided for under FASB Statement No. 123, Accounting for
Stock-Based Compensation. The effect of the change in accounting for stock-based
compensation will be to recognize stock compensation expense over the vesting
period for those stock options granted on or after January 1, 2002. For stock
options granted prior to January 1, 2002, we will continue to apply the
provisions under Accounting Principles Board Opinion No. 25 unless the stock
options are modified or settled for cash. The impact of adopting Statement No.
123 is not expected to have a material effect on our financial position and
results of operations.
32
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
----------------------------------------------------------
We are exposed to interest rate changes primarily as a result of our credit
facilities and long-term notes used to maintain liquidity and expand our real
estate investment portfolio and operations. Our interest rate risk management
objective is to limit the impact of interest rate changes on earnings and cash
flow and to lower our overall borrowing costs. To achieve these objectives we
issue long-term notes, primarily at fixed rates and may selectively enter into
derivative financial instruments such as interest rate lock agreements, interest
rate swaps and caps in order to mitigate our interest rate risk on a related
financial instrument. We are not a party to any derivative financial instruments
at June 30, 2002. We do not enter into any transactions for speculative or
trading purposes.
Our interest rate risk is monitored using a variety of techniques. The table
below presents the principal amounts, weighted average interest rates, fair
values and other terms required by year of expected maturity to evaluate the
expected cash flows and sensitivity to interest rate changes (dollars in table
in millions).
EXPECTED MATURITY DATA
---------------------------------------
2003 THEREAFTER TOTAL FAIR VALUE(2)
---- ---------- ----- -------------
Fixed rate debt -- $ 230.0(1) $ 230.0 $ 233.2
Average interest rate -- 7.99% 7.99%
Variable rate debt $155.8 -- $ 155.8 $ 155.8
Average interest rate 3.04% -- 3.04%
(1) $110 million matures in 2007, $100 million matures in 2008 and $20 million
matures in 2009.
(2) We base the fair value of the fixed rate debt at June 30, 2002 on the
closing market price or indicative price per each note. The fair value of the
variable rate debt approximates its carrying value because its terms are similar
to those available in the market place.
The table incorporates only those exposures that exist as of June 30, 2002, it
does not consider those exposures or positions that could arise after that date.
As a result, our ultimate realized gain or loss, with respect to interest rate
fluctuations, would depend on the exposures that arise during the period, our
hedging strategies at the time, and interest rates.
33
PART II. OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
---------------------------------------------------
The annual meeting of stockholders of Realty Income Corporation was held on May
7, 2002. Two incumbent directors were re-elected to the board of directors for
three year terms. Proxies for the meeting were solicited pursuant to Section
14(a) of the Securities Exchange Act of 1934 and there was no solicitation in
opposition to management's solicitations.
All of management's nominees for directors as listed in the proxy statement were
elected with the following vote:
YEAR
TERM SHARES AUTHORITY TO
EXPIRES VOTED FOR VOTE WITHHELD
---------------- ---------------------- -----------------------
Donald R. Cameron 2005 27,539,425 229,004
Willard H. Smith Jr. 2005 27,528,251 240,178
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
--------------------------------
A. EXHIBITS:
EXHIBIT NO. DESCRIPTION
- ----------- -----------
3.1 Articles of Incorporation of the Company (filed as Appendix B to
the Company's Proxy Statement dated March 28, 1997 ("1997 Proxy
Statement") and incorporated herein by reference).
3.2 Bylaws of the Company (filed as Appendix C to the Company's 1997
Proxy Statement and incorporated herein by reference).
3.3 Articles Supplementary of the Class A Junior Participating
Preferred Stock of Realty Income Corporation (filed as exhibit A
of exhibit 1 to Realty Income's registration statement on Form
8-A, dated June 26, 1998, and incorporated herein by reference).
3.4 Articles Supplementary to the Articles of Incorporation of Realty
Income Corporation classifying and designating the Class B
Preferred Stock (filed as exhibit 4.1 to the Company's Form 8-K
dated May 24, 1999 and incorporated herein by reference).
3.5 Articles Supplementary to the Articles of Incorporation of Realty
Income Corporation classifying and designating the Class C
Preferred Stock (filed as exhibit 4.1 to the Company's Form 8-K
dated July 29, 1999 and incorporated herein by reference).
4.1 Pricing Committee Resolutions and Form of 7.75% Notes due 2007
(filed as Exhibit 4.2 to the Company's Form 8-K dated May 5, 1997
and incorporated herein by reference).
4.2 Indenture dated as of May 6, 1997 between the Company and The
Bank of New York (filed as Exhibit 4.1 to the Company's Form 8-K
dated May 5, 1997 and incorporated herein by reference).
34
EXHIBIT NO. DESCRIPTION
- ----------- -----------
4.3 First Supplemental Indenture dated as of May 28, 1997, between
the Company and The Bank of New York (filed as Exhibit 4.3 to the
Company's Form 8-B and incorporated herein by reference).
4.4 Rights Agreement, dated as of June 25, 1998, between Realty
Income Corporation and The Bank of New York (filed as an exhibit
1 to the Company's registration statement on Form 8-A, dated June
26, 1998, and incorporated herein by reference).
4.5 Pricing Committee Resolutions (filed as an exhibit 4.2 to Realty
Income's Form 8-K, dated October 27, 1998 and incorporated herein
by reference).
4.6 Form of 8.25% Notes due 2008 (filed as exhibit 4.3 to Realty
Income's Form 8-K, dated October 27, 1998 and incorporated herein
by reference).
4.7 Indenture dated as of October 28, 1998 between Realty Income and
The Bank of New York (filed as exhibit 4.1 to Realty Income's
Form 8-K, dated October 27, 1998 and incorporated herein by
reference).
4.8 Pricing Committee Resolutions and Form of 8% Notes due 2009
(filed as exhibit 4.2 to Realty Income's Form 8-K, dated January
21, 1999 and incorporated herein by reference).
B. No reports on Form 8-K were filed by the registrant during the quarter for
which this report is filed.
On July 24, 2002, we filed a Form 8-K in connection with the issuance of
1,550,000 shares of the Company's common stock pursuant to the Company's
shelf registration statement on Form S-3 filed on June 16, 1999, as amended
on July 13, 1999.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended,
the registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
REALTY INCOME CORPORATION
(Signature and Title) /s/ GREGORY J. FAHEY
------------------------------------
Date: August 9, 2002 Gregory J. Fahey
Vice President, Controller
(Principal Accounting Officer)
EXHIBIT INDEX
Exhibit
No. Description
- --------- -----------
-- None